Wednesday, 12 March 2014

How The Federal Debt Will Affect Mortgages And Real Estate

There is a new threat to the mortgage market, which is the federal debt debacle playing out in Congress.

It all boils down to this. If the Congress cannot authorize the rise in the country's debt ceiling then the United States of America will have to default on some of its payments. The whole economy would be adversely affected and that includes the housing market. That's because a default will push up interest rates on every form of credit including mortgages. Some analysts are predicting that the interest rate increase could be as much as 1 percent.

It is said that 95 of every 100 home loans being written today are put into mortgage-backed securities that are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. When they guarantee securities, that guarantee is coming from the U.S. federal government. The inability to raise the debt ceiling would mean that the value of these guarantees would plummet because the U.S. government would have to default on some payments.

The way the system works is that when the value of the securities drop, then the securities market would immediately demand a much larger rate premium on new mortgage backed securities to compensate for the greater risk. The results will be sharply higher interest rates charged to new borrowers.

The adverse effect on borrowing will not just be one immediate reaction by the markets. Instead, it will be spread out for years. If there is a serious and extended problem, U.S. bond holders like China will demand higher interest rates. This will ripple through all the markets and cause the further increase of interest rates in the mortgage market. Of course, this, as well as problems in other markets resulting from such a move by bond holders will slow economic growth more and the results would be higher mortgage rates, a double dip recession or -- the worst result of all -- a full scale depression.

As previously mentioned, the increase in interest rates could be as much as 1 percent. This could cause a 1 percent decrease in economic growth and the loss of 800,000 jobs a year.

Moreover, many analysts are saying that it won't be just the higher interest rates that would be impacting the U.S. economy. As this crisis plays out stocks, bonds and the dollar itself could plummet and all of this will continue to buffet the mortgage market. as it affects everyone's ability to borrow money regardless the reason.

Furthermore, analysts say that the default could freeze the short term lending markets. Treasuries and other government-backed debt are used as collateral for loans and the value of these securities will be plummeting because rating agencies will downgrade U.S. debt. So lenders could demand that borrowers must provide more collateral which could force consumers to sell other investments. Analysts say that this could cause a selling cycle that would spread chaos across markets much like the Lehman Brothers collapse did in 2008.

The issue is not just the federal deficit and debt. The repercussions of a U.S. government default will ripple through every nook and cranny of the U.S. economy affecting everything including mortgage interest rates.

The housing market has taken enough of a hit already due to the Great Recession, the record rate of foreclosures, the plummeting value of homes and the reluctance of buyers to take the plunge and buy a home. It certainly doesn't need more problems caused by a small group in the U.S. Congress who demand that "It is our way or the highway!"